Beyond the scary LatAm headlines

The region's value untouched by Venezuela, Ecuador, say analysts

By

PolyaLesova

This story is the debut of a column on MarketWatch about emerging markets that will run several times a week.

NEW YORK (MarketWatch) -- Even as the Venezuelan Congress granted sweeping powers to firebrand President Hugo Chavez to rule by decree on Wednesday, analysts were saying the rest of the region's financial powerhouses are safe for investors.

At a plaza in downtown Caracas, lawmakers loyal to Chavez unanimously voted for the so-called "enabling law," which gives Chavez decree powers for 18 months, so he can mold Venezuela into a socialist republic, the Associated Press reported. That unbridled authority gives him the power to push ahead with radical measures like the nationalization of key industries and the revocation of central bank independence. See separate story.

The expansion of Chavez' powers is the latest in a series of moves that have eroded investor confidence in Venezuela as well as its regional neighbor Ecuador, whose President, Rafael Correa, is a Chavez ally who is threatening to default on his country's debt. On Wednesday Moody's Investors Service downgraded Ecuadorian debt deep into junk territory.

However, analysts said they're not looking for the decidedly non-investor friendly tone to spread throughout the rest of Latin America, where the biggest economies -- Brazil and Mexico -- present attractive opportunities with pro-market political leadership.

"With the election of Calderon in Mexico last year, that was the end of the pendulum swinging to the left in Latin America in terms of the major economies," said David Riedel, president of Riedel Research Group.

In Mexico, Felipe Calderon defeated a left-wing opponent to win the presidency last year. The business community favored Calderon, a Harvard-educated lawyer, who has vowed to continue the free-market policies of the previous administration.

In Brazil, President Luiz Inacio Lula da Silva, known as Lula, won a second term last year in a landslide victory. Lula, who was first elected as a left-wing president, has carefully positioned himself near the political center and has pledged to comply with the requirements of the International Monetary Fund.

"Lula has been reelected in Brazil, but his rhetoric has been very oriented towards growth of the broader economy rather than the confidence-destroying moves that we've seen in Venezuela and Ecuador," Riedel said.

No risk from Latin Left

Chavez and Correa have promised socialist revolutions to alleviate poverty and keep more of the wealth generated by commodity exports at home. Their confidence-destroying moves include nationalizing key industries and opposing free-trade agreements. Epitomized by President Chavez, their rhetoric is populist, incendiary and anti-American.

"The arrival to power of new leftist governments does not seem to threaten the macroeconomic discipline, with only very few exceptions led by Venezuela," said Alfredo Coutino and Juan Pablo Fuentes, economists at Moody's Economy.com, in a note presenting their outlook for Latin America in 2007.

"Markets have learned that the new Latin Left does not represent a risk, as long as they do not try to reverse the free-market model, but new governments have also learned that market punishment could be devastating in case of a radical return to the past populism," Coutino and Fuentes said.

So far, there is little evidence that investors are avoiding Latin America. A full $100 million in flows made their way into Latin America equity funds in the week ended Jan. 25, according to fund tracker Emerging Portfolio Fund Research.

The Latin America equity funds they track had $30.03 billion in total assets at the end of 2006 and attracted inflows of $3.58 billion last year.

The region has performed well too. The iShares S&P Latin American Fund
ILF, +0.35%
an exchange-traded fund that tracks the performance of the local markets, rose 38% in 2006. Among individual country ETFs, the iShares MSCI Brazil Fund
EWZ, +0.42%
rose 40%, the iShares MSCI Mexico fund
EWW, -0.04%
rose 43.5%.

Inflation has declined in most Latin American countries, with the exception of Venezuela and Argentina, where inflation is in the double digits. Countries with independent central banks -- such as Brazil, Chile, Colombia, Mexico and Peru -- have experienced greater price stability than those with lax monetary discipline, Coutino and Fuentes said.

"After a strong expansion in the last three years, Latin America is expected to moderate its growth in 2007," the economists said, citing lower commodity prices as one reason for the slowdown.

Moody's Economy.com expects Latin America to grow about 3.5% this year, as a result of the slowdown in Argentina, Venezuela and Mexico. In 2005, the economy grew by 4.5%, while in 2006 it grew an estimated 5.0%.

In Venezuela and Argentina, growth will moderate significantly after a continuous expansion in the past few years. Colombia and Peru will likely slow a bit less.

Slowdown, not recession

"The Mexican stock market will do fine, but not as well as last year," said Bond Snodgrass, the Mexico City-based founder of Snodgrass Research Group. "We've got very stretched valuations and we've got a slowing economy -- not a recession economy, but a slowing economy."

The Mexican stock market reacted very positively to the election of President Calderon last summer. The Mexican Bolsa was up 49% last year and 32% of that surge came after the presidential election, Snodgrass said. Now that the initial euphoria from the election is over, investors are waiting to see actual policy implementation, he said.

"The Chavez risk is practically nil and fully discounted in the market," Snodgrass said. "Most Mexican companies don't have any exposure there [in Venezuela]."

Among the Mexican stocks Snodgrass likes is Alsea S.A. (ALSEA), a fast-food restaurant company, which owns the Latin American franchises for Domino's Pizza, Starbucks Coffee, and Burger King. Other attractive companies include Axtel, the second largest phone company in Mexico, and Grupo Bimbo, the largest bakery company in the country.

"All three of them are very close to the Mexican consumer," Snodgrass said. "The valuation in none of them is particularly stretched and they have good balance sheets."

In contrast to Mexico, growth in Brazil and Chile will reaccelerate following last year's moderation, according to Moody's Economy.com.

"Within emerging markets, Brazil is still the most attractively priced market," said Will Landers, portfolio manager of the BlackRock Latin America Fund
MDLTX, +0.46%
which has $486.6 million in assets. In terms of the regional allocation of the fund, Brazil makes up 59.9% and Mexico accounts for 28.3%.

Brazil has a very strong currency, low inflation rates, and Lula's policies have been pro-growth, fiscally conservative, and focused on reducing debt levels, Landers said.

"Most of the buying has been foreign-led over the last two years," Landers said. "With interest rates coming down, local institutional investors are expected to move back into the equity markets."

Ignacio Goni, head of research for Latin America at Riedel Research Group Inc., follows the markets in Mexico, Brazil, Argentina and Chile. He said that Brazil's president Lula has "concentrated on what's most needed in Brazil -- boosting growth.

"Brazil has been growing at about 3% in the last three years, mainly because of controlling inflation," Goni said. "Those inflation fears are in the past. They have been lowering their interest rates and they'll continue to do so."

He said there are attractive investment opportunities in the Brazilian banking sector, which has had sensational growth recently: "I'm not expecting impressive gains, but I expect the growth to continue."

Among other Brazilian companies Goni recommended are cosmetics giant Natura and Votorantim Celulose E Papel
VCP, +0.51%
a pulp and paper producer based in São Paulo.

He also recommended Chile-based Lan Airlines SA
LFL, +24.63%
a passenger carrier in Latin America and the main cargo operator in the region.

As for Argentina, Goni, who is based in the capital Buenos Aires, is expecting another good year in terms of macroeconomics. In October, Argentineans will vote for a new president, and the popular incumbent Nestor Kirchner will be running for a second term.

In Argentina, Goni likes Tenaris S.A.
TS, +2.57%
a manufacturer and supplier of seamless steel pipe products to the oil and gas industries, as well as energy group Pampa Holding.

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